The Trouble with Iraq's Oil

The Daily Standard by Irwin M. Stelzer, contributing writer 04/29/2003 12:00:00 AM

Production is taking longer than expected to come online, four different groups are claiming the right to sell it, and if that weren't enough, we have the Saudis to worry about.

WHEN THE U.S.-UK-AUSTRALIA coalition found that Iraq's technicians had refused to torch their oil fields or damage pumping stations, buyers looked forward to falling crude prices. But analysts who had predicted that the liberation of Iraq would quickly increase the volume of crude oil coming onto world markets received a bit of a shock.

First, the OPEC cartel agreed to cut output by about 2 million barrels per day, or at least seemed to do so; the actual cut may have been one-fourth of that, depending on how you read the typically obscure press release. Then technicians discovered that Iraq's oil fields had been more starved of investment than anyone thought and that the looting of everything from tools and equipment to buses needed to transport workers will slow efforts to restore production to the level of pre-liberation days.

Equally annoying, the U.N. Security Council refuses to end its oil-for-food program by dropping its sanctions. Of course this comes as no surprise since the 2.5 percent over-ride the U.N. gets on all sales is used to feed the 3,000 person bureaucracy which administers the program. Also, Russia and France want to control the awarding of reconstruction contracts. The welfare of the Iraqi people ranks far below these concerns in the eyes of the United Nations.

All of which places a legal cloud over the title to Iraq's oil, with the right to sell it simultaneously claimed by the coalition, the United Nations, Mohammed Mohsen al-Zubaidi (an exile returned to Iraq to proclaim himself governor of Baghdad), and several Shiite clerics who are using the freedom won for them by the U.S. military to cry "Yankee go home" at rallies attended by the millions of their co-religionists who constitute 60 percent of the Iraqi population.

Some of these problems can be solved. The United States can simply ignore the United Nations and start selling Iraq's oil to fund the nation's reconstruction and relief, with U.S. guarantees of title. Or America can simply buy the oil on its account, paying into a trust fund for the Iraqi people.

But adding Iraqi oil to world markets might prove to be no easy task. When we promised to create a democracy in Iraq the administration apparently didn't consider the possibility that Iraq's 100 billion barrels of oil reserves (more than 9 percent of the world's total) might end up in the hands of an anti-American Islamic regime similar to that of Iran's. If the behavior of Iran (almost 9 percent of world reserves) is any guide, Iraq's new clerics-cum-oil moguls will be price hawks--a voice in OPEC for the low-production, high-price scenario that analysts were hoping a democratic Iraq would end.

There is worse. In Russia (almost 5 percent of world reserves), Yukos' acquisition of Sibneft creates a $35 billion behemoth that is unlikely to be a price-cutting scrambler for short-term revenue. Besides, construction of the pipeline and port infrastructure needed to bring more Russian oil to market will cost some $5 billion and be completed no earlier than 2007. So don't look to Russia for near-term price relief.

Or to Nigeria, America's fourth largest source of imports. With opposition parties threatening disruptions to protest the apparently fraudulent reelection of president Olusegun Obasanjo, the African nation is likely to remain less than a completely reliable supplier. Venezuela, another important U.S. supplier, sits on over 7 percent of world reserves, and is controlled by a pro-Castro president who has precipitated a supply-disrupting strike by politicizing the industry's management and is running the fields so badly that productive capacity has fallen. Mexico shows no sign of expanding capacity by dropping its ban on foreign investment in its oil business. And petroleum inventories in the United States are at their lowest level in more than 30 years.

True, oil markets have recently eased a bit. Gasoline prices are down 14 cents, from their mid-March peak of $1.73 per gallon, as additional pre-war crude produced by Saudi Arabia reached our shores, along with record imports of petroleum products. And the slowing of Asian growth incident to the SARS outbreak, continued recession in Germany and France, and reduced air travel everywhere are dampening demand.

So we have two conflicting signals. On the supply side, there are constraints both political and economic: unstable regimes, an active cartel that is threatening to cut back output, and shortages of infrastructure investment around the world. That should mean higher prices. But on the demand side, we have SARS, the collapse of air travel, and slow growth. That should mean lower prices.

Steve Strongin, director of commodity research at Goldman Sachs, has balanced these conflicting pulls on price and decided that crude will likely jump into the low $30s when the U.S. driving season starts in June. But when Iraq's oil hits the market in significant quantities, a downward move to OPEC's preferred range of $22-$28 per barrel is likely.

In the end, oil prices may depend on the willingness of OPEC to reduce current output from 26-27 million barrels per day to about 24.5 million barrels, and eventually to cut back even further to make room for Iraq to reenter the market. The biggest reductions will have to be taken by the Saudis.

And there's the rub. If Bush is serious about waging war on terrorism, he will have to put pressure on the Saudis to stop funding the worldwide spread of the creed that underlies it. But the president needs the Saudis. Since he can't persuade Congress to give him the tax cuts he has asked for, he needs a different stimulus--oil prices low enough keep consumers in the malls, auto showrooms, and estate agents' offices.

The ultimate irony: The elder Bush was disliked by many of the younger Bush's ardent supporters for kowtowing to the Saudi royal family. These folks now find themselves serving a president whose reelection might depend on the favor of those very same royals. It is the price America pays for its inability to develop a policy to reduce its dependence on Saudi oil.

Irwin M. Stelzer is director of regulatory studies at the Hudson Institute, a columnist for the Sunday Times (London), a contributing editor to The Weekly Standard, and a contributing writer to The Daily Standard.